THE INDEPENDENT DIRECTORS’ ROLE IN EUROPE: DEVELOPMENTS

AND OPEN DEBATES IN ITALY

15 COLUM. J. EUR. L. ONLINE 77 (2009)

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Serena Scarabotti

I. INTRODUCTION

On July 17, 2007, the European Commission published a report (the “Report”)[1] on
Member State implementation of Recommendation 2005/162/EC(the
“Recommendation”). This Recommendation addresses the role of non-executive or
supervisory directors of listed companies and that of the (supervisory) board’s
committees. It was adopted to promote standards ensuring that the boards of listed
companies offer sufficient guarantees of independence. In doing so, it promotes the
convergence of the national corporate governance codes enacted in the Member States,
so that investors may benefit from an equivalent level of protection and transparency
within the European Community. In addition to contributing to the business efficiency in
the internal market, the Recommendation is also a response to recent corporate fraud
scandals.[3] As the Member States were invited to implement the Recommendation by
June 30, 2006, the purpose of the Report was to evaluate whether Member States have
developed the necessary legal framework to give effect to the Commission’s key
proposals.[4]

This article outlines the Recommendation’s most important innovations, with specific
regard to independent directors’ role. These proposals are to be implemented in the
Member States either through legislation or through best practice rules based on the
flexible “comply or explain” principle.[5] In particular, this article focuses on the Italian
experience of regulating the role of independent directors so as to ensure that they act in
accordance with European guidelines. To this day, corporate governance remains a
central issue in Italy, especially in light of the December 18, 2008 judgment issued by a
Milan court concerning Calisto Tanzi.[6] The Court sentenced Tanzi, a former chief
executive officer of Parmalat-which collapsed five years ago in a massive fraud-to 10
years of imprisonment.[7] The Parmalat case[8] represents one of the most glaring
examples of corporate governance abuses. It has contributed to the creation of the
Italian corporate governance system ensuring the presence of independent directors in
the boards of listed companies.[9] The Parmalat debacle demonstrates that the question
is still open on whether the “comply or explain” principle is a valid safeguard for
corporate governance and, if so, what measures need be introduced in Italy so as to
render it really efficient. This brief article aims at proposing a few preliminary
suggestions in what appears to be an open and ongoing debate.

II. THE IMPORTANCE OF INDEPENDENT DIRECTORS

Independent directors play a key role in the corporate governance system that has been
developed in Europe, following the Sarbanes-Oxley Act in the United States. The basic
idea is that corporate governance should ensure that boards exercise appropriate
scrutiny over management and shareholders (in their capacity as owners of the
company)[11]. Boards are thought less likely to exercise efficient monitoring if they are
composed of individuals who either maintain close ties to the management or lack the
appropriate expertise. Independence is particularly crucial in those areas which involve a
potential conflict of interests between managers and shareholders: for example,
appointment of the management, manager’s pay, and auditing of the company’s
performance.[12]
III. THE RECOMMENDATION’S KEY ADVANCES

One of the most important objectives of the Recommendation is to promote the function
of independent, non-executive or supervisory directors in major fields of potential
conflicts of interests between management and shareholders.[13] To this end, the
following key points have been outlined by the Recommendation:

A. Separation of the role of Chief Executive Director and (supervisory) Board [14]

The administrative, managerial, and supervisory bodies should include an appropriate

balance of executive/managing and non-executive/supervisory directors so as to avoid
allowing any individual or group of individuals coming to dominate the decision-making
process.

B. Sufficient number of Independent Directors [15]

“[A] sufficient number of independent non-executive or supervisory directors should be

elected to the (supervisory) board of companies to ensure that any material conflict of
interests involving directors will be properly dealt with.”[16] Independence means
freedom from any business, family, or other relationship with the company, its controlling
shareholder, or the management.

C. Creation of Board Committees to solve conflict of interests [17]

Three types of committees should be created within the (supervisory) boards-

nomination, remuneration, and audit-whenever these dutiesare not the direct
responsibility of shareholders. The presence of independent non-executive directors in
such committees is strongly emphasized.

D. Transparency concerning Independent Board Members [18]

The disclosure of individual directors’ competences and of adequate information on the

board’s determination of the directors’ independence is strongly advised.

E. High standards for the qualifications and commitment of (supervisory) Board

Members [19]

For a (supervisory) board to be efficiently set up, its members should have, taken
together, the “required diversity of knowledge, judgment, and experience to complete
their tasks properly.” More specifically, directors should devote sufficient time and
attention to their work by limiting their other professional commitments (especially in
case of directorships in other companies) and/or disclosing their other assignments and
significant professional commitments.

IV. THE VIEW FROM ITALY: THE PREDA CODE AND INDEPENDENT DIRECTORS

The European Union and the United States have essentially identified the same issues
and goals in corporate governance-that is, the importance of good corporate governance
for the benefit of investors and the economy. Yet, unlike the Sarbanes-Oxley Act, which
imposes mandatory provisions for U.S. companies (through a one-size-fits-all approach),
the corporate governance initiatives proposed in the European Union are not intended to
be mandatory.[20] Self-regulation through corporate governance codes, which merely
requires public companies to disclose whether or not they are in compliance with the
codes, is a typical feature of the European approach to corporate governance.

In Italy, independence standards for directors are provided by the Italian corporate
governance code (the “Preda Code”) as well as the Recommendation. Borsa Italiana
S.p.A., the Italian stock exchange, implemented the Preda Code in 1999. The Code was
later updated in 2002 and2006 after the major Cirio[24] and Parmalat financial
scandals.

Despite the fact that the Preda Code’s provisions are generally not mandatory, they
require all Italian listed companies to present a yearly corporate governance report
declaring whether and to what extent they conform to the Code. This reporting system
stems from the “comply-or-explain”principle, which allows companies to apply corporate
governance principles with an eye to their own specificities. In this context, the
Recommendation works as a proxy for international best practice. Article 3 of the Preda
Code requires independence of judgment for all directors.[25] Nonetheless, only non-
executive directors may provide an “independent and unbiased judgment on proposed
resolutions, they are not directly involved in the running of the company.”[26] For this
reason, the Preda Code refers to a non-executive director as an “independent
director.”[27]

Furthermore, the Preda Code addresses the most common symptoms of lack of
independence. However, these provisions are purely explanatory and not binding, as the
board of directors may adopt additional or different criteria by giving “adequate
information” about the effectiveness of any different evaluation in terms of
independence.[28] The Preda Code favors a case by case approach to the extent that
each board needs to evaluate the fulfillment of the independence requirements.[29] The
evaluation of non-executives’ independence should be made on a substantial rather than
formal basis.

In particular, as to the “commercial, financial, and professional relations directly or

indirectly entertained by the director with the issuer,”[30] the corporate governance
committee (the “Committee”)[31] has not set out specific criteria to assess
independence. The board is in charge of evaluating the materiality of such relationships,
“both in objective terms and in relation to the economic-financial situation of the party
concerned.”[32] According to the commentary accompanying the Preda Code, the key to
determining whether a relationship is “material” is whether the director is benefiting in a
way “not aligned with the market.”[33] The Committee is careful to note, however, that
there is no relationship that can be considered de facto independent, that is, all
relationships must be put to the test.[34]

It should also be noted that the customary structure of Italian administrative bodies
includes the possibility that certain directors are independent even though they are
members of the executive committee of the issuer, in part because the executive
committee does not necessarily confer individual powers to its members. The Committee
focuses on the objectivity of the independence requirements, irrespective of whether the
shareholders have appointed the directors.[35] As a result, independent directors’
appointments may be proposed alternatively by the majority or minority shareholders
since, in any case, the independence requirement shall be verified based on actual
practice, following the Preda Code and the Recommendation’s guidelines.[36]

V. THE “COMPLY OR EXPLAIN” PRINCIPLE

The Report concludes that “a majority of Member States [have] compl[ied] at least to a
large extent with the recommendations,” and, as the preceding discussion demonstrates,
Italy is no exception.[37] Nonetheless, with an eye to all Member States, the Commission
is concerned with the practical efficiency of the “comply or explain” principle, which has
inspired, among others, the Italian corporate governance scheme. In the Commission’s
opinion, the success of such a principle “will depend largely on the quality of the
information provided in the corporate governance statement.”[38] In addition, even the
“[t]ransparency requirements may be insufficient if shareholders do not take a pro-active
and critical attitude toward the decisions of the management and do not seek changes in
corporate governance policies and structures . . . .”[39] Taking into account all these
concerns, the Commission expressed its intention to continue monitoring the
implementation of the Recommendation across Member States.[40]

VI. RECENT DEVELOPMENT IN THE ONGOING ITALIAN DEBATE OVER CORPORATE

GOVERNANCE

The debate over the efficiency of corporate governance systems is alive and well in Italy,
and Italian legislators still appear willing to test the actual efficacy of the “comply or
explain” principle.[41] For example, to respond to the Commission’s concern about the
efficiency of the “comply or explain” principle, Italy implemented Directive 2006/46/EC in
November 2008.[43] More specifically, since the amendment of Article 123-bis by
Legislative Decree 58/1998 (the so-called “Consolidated Financial Act”)[44], it is now
mandatory for EU listed companies to publish management reports including information
on the adoption of a corporate governance code. Because even the best corporate
governance codes may remain powerless so long as they do not impose a real
requirement to comply or explain, Directive 2006/46/EC contributes to enhancing
transparency and to monitoring compliance progresses.

Furthermore, potential conflicts of interest in related party transactions and executive

contracts remain a significant concern in Italy. Consequently, in September 2008 the
Commissione Nazionale Società e Borsa (“CONSOB”), the Italian securities market
regulator, has launched a consultation process concerning the need to enhance
independent directors’ role with regard to related parties transaction.[45] CONSOB
focuses on the central function of independent directors in approving related parties
transactions so as to ensure efficient and transparent management procedures. In
addition to the various disclosure duties still applicable to listed companies, CONSOB is of
the opinion that a deep involvement of independent directors in executing relatedparties
transactions would help reduce risks of conflicts of interest.[46]

The measures highlighted above reflect the continuing and compelling need for an actual
and efficient implementation of corporate governance rules in Italy which would align
agency costs and asymmetry of information between management and ownership of
companies.[47] Will such measures succeed in pursuing this goal? Will they allow
investors to consider explanations and to dialogue with companies where issues arise?
Will the enforcement mechanism of the “comply or explain” rule be powerful? These
questions have yet to be answered in Italy where an efficient system of corporate
governance is even more needed after the Parmalat collapse.

Endnotes

[3] See, e.g., Claudio Storelli, Corporate Governance Failure-Is Parmalat Europe’s Enron?,
COLUM. BUS. L. REV. 765, 767-70 (2005) (discussing the importance of the Parmalat
case, which highlighted the inherent danger of concentrating the functions of chief
executive and of chairman of the board in the hands of the same person).

[4] Commission Report, supra note 1, at 3.

[5] Recommendation 2005/162/EC, supra note 2, recitals 4, 5 & ¶¶ 1.1, 1.2, 1.3.2.

[6] Mara Monti, Tanzi, Dieci Anni per Aggiotaggio, IL SOLE 24 ORE, Dec. 19, 2008.

[7] Vincent Boland, Parmalat Ex-Chief Sentenced to 10 Years, FINANCIAL TIMES, Dec. 18,
2008.

[8] For a general introduction to the issues related to the Parmalat case and its
implications for the development of Italian corporate governance, see Guido Alessandro
Ferrarini & Paolo Giudici, Financial Scandals and the Role of Private Enforcement: The
Parmalat Case (Eur. Corp. Gov. Inst., Law Working Paper No. 40, 2005).

[9] Commission Communication, Modernizing Company Law and Enhancing Corporate

Governance in the European Union-A Plan to Move Forward, COM (2003) 284 final (May
21, 2003).

[11] Florence Shu-Acquaye, Corporate Governance Issues: United States and the
European Union, 29 HOUS. J. INT’L L. 583, 593 (2007).

[12] Recommendation 2005/162/EC, supra note 2, recital 9; see also id. annex I.

[13] Id.

[14] Id. ¶ 3.2

[15] Recommendation 2005/162/EC, supra note 2, ¶ 13.

[16] Commission Report, supra note 1.

[17] Recommendation 2005/162/EC, supra note 2, ¶ 7.

[18] Id. ¶ 9.

[19] Id. ¶ 11.1; Commission Report, supra note 1, at 5.

[20] Elias Mossos, Sarbanes-Oxley Goes to Europe: A Comparative Analysis of United

States and European Union Corporate Governance Reform after Enron, CURRENTS: INT’L
TRADE L.J., Summer 2004, at 9

[24] Analytical discussion of the Parmalat and Cirio cases, always associated in terms of
representative Italian financial scandals, and their effects on financial markets can be
found in Cirio, Parmalat e Dintorni: Finanza, Industria, Regole, BORSA 2004: RAPPORTO
REF SUL MERCATO AZIONARIO 105 (2004).

[25] Codice di autodisciplina, supra note 23, art. 3 cmt. at 23.

[26] Id.

[27] Id. The comment states that the label “does not express a judgment of value, but it
rather indicates an actually existing [sic] situation: the absence . . . of any relation with
the issuer . . . .”

[28] Id. at 11.

[29] Id.

[30] Id. art. 3 cmt. at 24-25.

[31] The corporate governance committee is the committee in charge of drafting the
Preda Code.

[32] Codice di autodisciplina, supra note 23, art. 3 cmt. at 25.

[33] Id.
[34] Id. The comments undertake a non-exhaustive list of possibly material relationships,
including those that are governed by market conditions, non-economically significant, or
are indirectly traceable to corporate representatives, as well as relationships created by
political activity or familial relationships of directors. Id.

[35] Id.

[36] Id.

[37] Commission Report, supra note 1, at 9.

[38] Id.

[39] Id. at 10.

[40] Id. at 9-10.

[41] Id. at 9.

[42] Parliament & Council Directive 2006/46/EC, 2006 O.J. (L 224) 1.

[43] Directive 2006/46/EC has been implemented in Italy in November 2008 through
Legislative Decree 173/2008, Gazz. Uff. No. 260, Nov. 2, 2008, amending Article 123-bis
of the Consolidated Financial Act, which deals specifically with reporting requirements on
corporate governance and ownership structure.

[44] Gazz. Uff. No. 71, Mar. 26, 2008.

[45]vCommissione Nazionale Società e Borsa (CONSOB), Disciplina Regolamentare di

attuazione dell’art. 2391-bis del Codice Civile in materia di operazioni con parti correlate.

[46] Id. at 4.

[47] Guido Ferrarini, Ruolo degli amministratori indipendenti e Lead Independent

Director, in LA CORPORATE GOVERNANCE E IL RISPARMIO GESTITO 35 (2006).

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